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He was talking about a recession. Which might happen. (since people feel like it is getting closer)

If you know a stock which actually goes up in a recession, please let me know!

Haha it's not really about the stock itself. It's about how you bet in the market. If you truly believe that the market will fall, you can short sell and index fund or purchase some put options on that index. If the market does fall, you will make money as a result.

You just need to make sure the instrument you are betting against is representative of the overall market.

Okay... but who issues the instruments? I mean, what happened to instruments sold by Bear Sterns when they were acquired?

And what instruments are you actually buying? Are there put and call options for CoreLogic Case-Shiller???

Many large market makers issue these instruments.

They are not traded OTC and thus would not face liquidity problems like the OTC instruments people couldn't offload during the GFC (specifically like those guys in the Big Short).

As far as what the instruments actually are: they are puts on broader market REITs/ETFs as well as localized ones. We cannot name the specific instruments as we do not want their prices being bid up.

Hope this clarifies and of course happy to answer any more questions you may have!

Options.

Buy put or sell calls on an asset that's highly correlated with the overall economy. This is honestly the least controversial claim the OP is making.

Correlations change. You never know if gold might tank along with assets in the next recession. Or if yields will tank along with assets in the next recession. What if there's just hyper inflation?

No one knows what's going to happen...

You can go with Dalio's claim that as long as you have 10 hedges that are sufficiently un-correlated, your risk is incredibly low. But even that might not hold up under future unknown conditions.

You're absolutely right about the correlation changes. However, gold's correlation to the general market was developed organically by human behavior over time. That does often change during crisis.

However, options contracts are a form of derivatives, meaning they are contracts financially engineered to hold a specific correlation. So, you can build perfect hedges using options contracts, which is what they were originally invented for. People just started betting on the markets with them, which created all kinds of risks in the market.

There is no such thing as a perfect hedge. Delta hedging is not perfect and cannot be done continually.

https://en.wikipedia.org/wiki/Short_(finance)

That's more clear.

What happens if the house goes down 25%? I have coverage on the first 20%, and then I'm liable for the other 5%?

Any loss above 20% will be covered by the options purchased at the inception of the contract that go up in price if the real estate market suffers a larger drop (>20%).

So we personally guarantee up to a 20% drop with our own capital and use financial instruments to hedge any drop greater than 20% so as to make you whole regardless of the size of the drop.

Thanks, that's much more clear. I'm still confused about how you make that guarantee on the first 20%. You keep it in reserve?

Edit: generally, I wonder if you have a huge perception problem even if you've designed a responsible insurance product due to the fact that people are (reasonably) suspicious of taking on enormous amounts of counter-party risk from a pre-seed start-up.

Yep! That's exactly right. We keep that in reserve in a 3rd party account :)

Also, you have a great point on the perception problem, which is what we are trying to tackle right now. We have genuinely designed a product that is meant to be the most customer-friendly buyer model out there, but because we are a seed-stage company, many people are just concerned, because we lack a long standing reputation in the industry.

> As a result, we might not be able to pay you back

This is an absolute non-starter.

Sorry to be blunt, guys, but if you can't cover your promises, they aren't promises.

Your customers should be nuts to agree with this. Or misinformed. Again, sorry, I don't want to bash you, but what you are offering is simply too bad for your customers.

And then it goes on to say:

to make sure we can pay you back we buy financial instruments on the open market, kind of like buying a stock of apple for example. These instruments work in a very interesting way. Their prices go up, if the real estate market goes down. Their prices go down, if the real estate market goes up.

So, with these instruments. We can ensure that in the event of a recession, we can still afford to pay you back

> Their prices go up, if the real estate market goes down.

Hopefully they provide more detail here.

I'm old enough to remember 2008 and recall many financial instruments with a traditionally inverse correlation to each other behaving unexpectedly. Similar unexpected behavior led to the LTCM crisis in 1998.

My father -- born in 1922, grew up in The Great Depression -- always said "The best way to double your money is fold it in half and stick it in your pocket."

There are no guarantees in life (except maybe death and taxes). They seem to be taking reasonable precautions. They don't deserve to be lambasted for being a bit green and failing to phrase their comment like smarmy con artists pretending there is zero risk -- just trust me (wide, toothy grin).

Thanks for the kind words Doreen, your father sounds like a wise man :)

We have tried to engineer the agreement to the point where only during times of nuclear war or some crazy natural disaster, would we not be able to cover the losses.

And per our contract, we are not liable for these act of god events. So, we recommend all of our customers to purchase insurance on property, especially if they live in risky areas related to weather phenomenons.

Down the line, our priority is to incorporate climate modeling , so that we just no longer recommend properties prone to natural disaster damages.

You're correct in that many financial instruments with traditionally inverse correlation started moving differently. However, this is mainly from the natural correlation between two instruments that may develop over time.

For example, assuming the cell phone market only had 2 players, apple and samsung. And let's assume investors think it's a winner takes all market. So, historically, if apple shares went up, it means investors think they will dominate, which means investors think samsung will lose. This may lead samsung stock to decline when apple stocks increase and vice-versa.

Now imagine a recession. Investors don't care about that relationship anymore, because they just want to pull their money out of the market. Now everyone is dumping both apple and sumsung, so now, the correlation has changed.

I assume this is what you are talking about for the instruments you were mentioning. But, we use options, which are artificially created, so when we buy put options, they will always be 100% inversely correlated to the underlying REIT/ETF. Therefore, if the REIT/ETF goes down during a recession, our options will increase in price.

Hope this clarifies things!

Sorry that the post wasn't as clear. My intention with that line was to walk people through the process step by step.

Of course, we engineer the product so that we can pay people back. But I wanted to show people our thought process, which is what happens if there was a recession and most of our portfolio declines by more than 20%. If we didn't have hedging instruments, we wouldn't be able to pay people back.

Therefore, our next step was to purchase hedging instruments for every contract we take part in. Hope this clarifies things. If not, let me know, and I'll be happy to elaborate more.

Are each contract's hedging instruments independently hedged some how? I read that you invest in markets that "go up" if housing goes down, but let's take the 2008 financial crisis how do you defend against a rolling collapse? Are the markets you're betting in truly independent from each other? How much failure in the markets can you weather? Copious amounts of secret sauce?

Seems like an awesome idea in principle...

> The problem is if a recession happens, then a lot of our properties actually decline in value.

So, you've hedged against a broad real-estate market decline, but you aren't just making broad, representative real-estate market investments, you are investing in properties selected by the combination of your algorithm and customer choices. There is no guarantee that the subset of the properties selected by your algorithm that also appeal to buyers interested in your product will perform as well as the general market (your algorithm could turn out to suck[0], your customers could simply happen to select the worst of your algorithm’s recommendations, or an unpredictable event could occur which negatively impact values in a subset of the market which just happens to disproportionately correlate with the properties your customers selected.)

[0] And, sure, you think it doesn't, but the problem with any ML algorithm that is supposed to outsmart the market is that the market is full of people using tools like that to try to outsmart the market.